Another day older and deeper in debt

For me the story is a simple one: Economic growth has been slowing for half a century because the inflation is cost-push. Demand-pull grows the economy; cost-push slows it. The cost pressure arises not from the examples that are unfailingly used on the internet (wages and oil) but from excessive use of credit. In this, I guess you could say I agree with those who hold the "debt supercycle" accountable, with those who say we have "too much finance", and with those who speak ill of financialization.

By the way, our vast government debt is part of the problem, but it is the least worrisome part. It is private-sector debt service that consumes private-sector income and slows private-sector growth. Since Keynes, government debt has been a rescue system for the private sector economy, and the first thing to realize is that the incredible size of the federal debt, as we apparently need that much rescuing, is evidence of how bad things have become in the private sector.

The second thing to realize is that the solution we have applied to the problem for the past fifty years has not worked, and this failure is evidence that we misunderstand the problem.

The cause of the excessive growth of finance is economic policy: human nature, and economic policy. The policy part of the problem is that for far too long we thought using credit was good for growth, and that the resulting accumulation of debt was not a problem. The human nature part is that we are too willing to borrow. 

When we borrow, we get money to spend. That's the use of credit, and it is indeed good for the economy. It boosts spending. It boosts the economy. But when we borrow money we take on debt. And debt must be repaid. Repayment takes money out of the economy, reduces spending, and slows economic growth. There is no free lunch: The boost we get by borrowing money comes with a drag on the economy that takes effect when we repay the debt. 

The debt supercycle is good in the early stages when debt is low. It is harmful in the late stages when debt is high. This is why our economy was great for a generation after World War Two, then pretty good for a generation, and bad in the years since. 

These days are late in the debt supercycle. We didn't know. We let the problem fester until we had the 2008 financial crisis. Our economy was slow for a decade after that. In recent years things seem to be improving -- but that is only because our use of credit has been increasing again. It's human nature: We are too willing to borrow money. But of course you can't change human nature. We need policy to protect us from ourselves -- but no! We need policy to protect the economy from human nature, to reduce our debt and keep it low so that our economy can improve. We need the opposite of the policy we have.

Our economy is bad because debt costs money and we have a lot of debt. Because the economy is bad, repayment of debt has become more difficult. We have... no! Policy has put us in a hole that is almost impossible to get out of. And since we can't get out of that hole, our economy cannot recover. Policy must stop encouraging us to be in debt. Policy must start encouraging us to get out of debt. And, as the problem is still so very bad, policy should begin by helping us get out of debt. Then, as the economy recovers, policy can prune back that help. But it must forever keep the policies that encourage us out of debt.

What we should shoot for, really, is the optimum level of debt, the level that best promotes economic growth. If you never thought about that, I have two blog posts you might want to read. First, some preliminary thoughts on the topic, in Two Thought Experiments. Second, some tentative targets for policy, in Establishing Parameters for Debt.